Update – A reader in Switzerland writes to inform me that the cost of a safe deposit box, insurance and transport averages -0.125%, but the SNB is currently charging -0.75% so there is in fact empirical evidence that my thinking on this is correct. That is, the theoretical floor on negative interest rates is not the cost of holding cash in storage…I also confirmed with my own bank that storage is free for high account balances. So the marginal wealthy account holder won’t pay storage costs even if interest rates are negative.
Just a short comment here on the debate about negative interest rates and the zero lower bound. I see that many economists are debating how low interest rates can go (see Sumner, Krugman and Soltas). They seem to have concluded that interest rates can go as low as…the cost of a safety deposit box. The basic logic (if we can you call it that) is that people will carry negative interest deposits so long as it costs less than storing cash. Evan Soltas ran through some figures on the cost of using a safe deposit box and Paul Krugman and Scott Sumner basically agreed with his analysis. They figured it all out!
Sadly, this is why economists are often scoffed at. This analysis is so detached from reality that it can hardly be taken seriously. How many people actually use a safe deposit box? I mean, the average American doesn’t even have $4,000 in total savings. 27% have NO emergency savings at all. And three quarters of Americans don’t have enough emergency savings to last 6 months. Yet a group of economists have all agreed that the cost of a safety deposit box, something used almost exclusively by people who have money pouring out of their ears (ie, not even close to most of the people in the economy), is going to be the primary driving factor in whether people will hold cash relative to deposits. According to this theory, yields are determined by a small group of wealthy people who hold safety deposit boxes and calculate the cost/benefit of holding cash versus deposits. I just don’t see how this can be remotely realistic because this just isn’t how people think about their deposits – that is, should I hold my deposits in a bank account or in the bank vault? This would be, a marginal impact, at best given the fact that so few people would actually engage in such behavior.
I think it’s much more realistic to assume that, if the Central Bank wants to establish a negative rate on deposits, it will charge banks a rate on reserves which will act as a tax on banks which banks will try to pass along in various forms. In essence, the cost of a vault will change as a result of the Central Bank policy. Rates will not be determined by rich people looking to store cash in vaults. And Central Bank policy will only remain as onerous on the banks as the Central Bank allows it to become. That is, the Central Bank won’t cause a run on deposits if it becomes clear that a negative interest rate is causing exactly that. So the whole theory of focusing on storage costs gets it backwards to begin with.
This is the sort of “analysis” that drives non-economists mad. It is so wildly detached from reality that you have to scratch your head wondering how economists could come to the sorts of conclusions they do. It makes you wonder if any of their models are even remotely representative of reality or if they’re just purely theoretical nonsense. It’s as if they have almost no experience operating in the actual economy at times. Of course, I am unfairly throwing all “economists” under the bus, but this is a fairly widespread problem as we can see in this instance. And I apologize to the fine economists who aren’t totally detached from the economy the rest of us actually use on a daily basis…..
Anyway, we should probably stop thinking about these things and get back to counting these bills in my many safe deposit boxes.
Addendum – several economists wrote me to express their displeasure about this post. They say I am being too critical. Well, I am being critical. That was the point. Economists play a very important role in our world by establishing the framework through which policymakers interpret and influence the world. When their models are wildly unrealistic it hurts us all. I don’t point out errors in modern mainstream econ because I am trying to hurt people’s feelings. I point out the errors because I am trying to provide an alternative perspective to what often appears like ivory tower theorizing. And if I am right then the errors should turn into a more constructive and realistic debate going forward. It’s all in the interest of becoming better informed and hopefully generating better conclusions. Sorry if it comes across as abrasive. That is not my intent
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.